Hello and welcome. You are listening to Patrick
Boyle on Finance, a podcast exploring ideas from
quantitative finance, examining events occurring in markets
right now and financial history to see what lessons can be taken
away, including interviews with some of the most interesting
people in the world of finance. To learn more about the podcast,
visit on finance.org. The British government is on the
verge of agreeing to an almost $800 million bailout for Jingyi
Group, the Chinese owners of British Steel.
Rishi Sunak's government already agreed to an almost $700 million
subsidy for Indian owned Tata Steel if they replace their 2
remaining UK based blast furnaces with more
environmentally friendly electric arc furnaces.
These are two of the largest state support packages in
British history. The outgoing Conservative
government didn't sign the Tata deal before the recent election
and the new Labor government has now said that they will make job
guarantees a requirement of any state support package offered to
Tata Steel. Last year, the British
government offered $700 million in subsidies to Tata, the owner
of Jaguar Land Rover, to persuade them to build a new
battery plant in the UK. They agreed to $100 million in
subsidies for German owned BMW to continue building the
electric Mini in the UK and $100 million to Nissan to safeguard
the Japanese owned company's future in the UK.
Do these bailouts and subsidies to foreign owned companies make
any sense for British taxpayers? And if they are paid, can
taxpayers expect these companies to stop coming back for more
government handouts by threatening layoffs again in the
future? Many foreign owned companies do
ask for and get subsidies. But the steel industry is
possibly the most interesting of this group because governments
around the world worry about losing their steel industries,
both for fear of losing manufacturing jobs and for
strategic military reasons. The American Iron and Steel
Institute, for example, highlights on its website that
all segments of the American steel industry contribute to the
defence industrial base. The British steel making
industry has unfortunately been in decline for quite some time,
which is a sad thing to say for the country that invented modern
steel manufacturing. Before 1860, steel was a very
expensive product that was made in small quantities and used to
manufacture precision tools and cutlery.
The Bessemer process developed in England made steel easier,
quicker and cheaper to manufacture.
In 1875, Britain led the world, accounting for 40% of global
steel production, the majority of which was exported. 25 years
later, the United States had become the market leader and
Germany was catching up quickly. The British iron and steel
industry first came under government control during the
Second World War as part of the war effort.
After the war, the Labour Party won a landslide victory and
established an iron and steel board to control the price of
raw materials, finished products, and the development of
new plant and equipment. A few years later they
nationalized the steel industry with the passage of the Iron and
Steel Act. This was reversed by the
Conservative government who were elected in 1951, but the
industry was nationalized once again in 1967 under a Labour
government as British Steel. Under the nationalization in the
60s and 70's, the government's goal was to keep employment as
high as possible, especially in industrial regions.
Many of the steel plants at this time were overstaffed, pay was
higher than average, and British Steel was unprofitable.
It was only able to stay in business because of government
subsidies. In the early 1970's, the British
steel industry employed around 320,000 people.
By 1991 that figure had fallen to just 44,000 workers and today
it employs around 30,000 people. The British steel industry is
today ranked 26th globally and comprises 6 steel mills, four of
which are blast furnaces. According to government
documents, the decline in the steel industry employment can be
explained by increased productivity as fewer workers
are needed in modern factories, but the job losses are mostly
explained by foreign competition, particularly from
China where manufacturing costs are significantly lower.
Britain's new net zero laws mean that the four remaining blast
furnaces, two of which are operated by Tata and the other
two by British Steel, have to be replaced with electric arc
furnaces to reduce their CO2 output.
When the subsidy deal for Tata was announced, the government
said that the new electric furnaces would cut the country's
total carbon emissions by around 1 1/2 percent.
There's been some concern in the UK that as global tensions have
been rising and other countries have focused on supply chain
resilience, that these new, greener furnaces can't make
Virgin steel and instead just recycle steel, which some
industry experts say can't be used for military purposes.
To be clear, Virgin steel has nothing to do with Richard
Branson. It's just primary steel made
from iron ore, while the newer technology is cleaner, more
efficient and requires fewer workers.
Britain, which was once the world's largest steel producer,
may soon become the first major economy with no capacity to make
steel from scratch. One of the biggest arguments in
favour of subsidizing Tata and Jingyi Group, the owners of
British Steel, is that if they were allowed to go bankrupt,
Britain would have no remaining steel industry.
Tata and Jingyi manufacture almost 6,000,000 tons of the 7.2
million tons of steel produced in the UK each year.
Under the current plans, all four of the remaining blast
furnaces will be shut down anyhow while the new electric
arc furnaces are being built, which will take a minimum of
three years, assuming no time overruns.
And in the meantime, Britain will be importing almost all of
it's steel. So one way or another, Britain
will be importing almost all of it's steel over the next few
years. A big part of the pro subsidy
argument is that if these furnaces were permanently shut
down, the UK might be dangerously exposed,
particularly in the case of war. There's even been some press
about how with the upgraded furnaces, Britain could still
find itself in a strategically weak position, as whence the
blast furnaces go away, the country will no longer be
producing virgin steel, meaning steel made from the primary raw
materials. To explain the difference, 70%
of the world's steel is today made using basic oxygen
furnaces, like the ones being shut down, which burn coal to
melt iron ore to extract the iron.
This iron can then be turned into steel.
Most of the inputs to this process are mined raw materials,
and the carbon footprint of virgin steel can be up to five
times greater than the carbon footprint of recycled steel when
you take the carbon intensive nature of mining into account.
The electric arc furnaces, on the other hand, take scrap steel
and use a massive electrical current to melt it down, and
with some processing, the end product is recycled steel, which
has a much lower carbon footprint, according to a blog
post by Ed Conway, the author of the book Material World.
I'll put a link to the book and his blog in the description.
Electric arc furnaces historically produced
significantly worse steel than the virgin steel that comes from
primary steel works. In the past, this recycled steel
was good enough for making things like rebar, which is used
in construction, but was not good enough for advanced uses.
Conway explains that this is no longer the case.
He points out that the steel that goes into aircraft landing
gear, which is apparently one of the finest grades in the world,
is made today in the electric arc furnaces at Rotherham.
The steel used to make nuclear submarines and parts for nuclear
power stations is made by Sheffield Forgemasters, once
again in electric arc furnaces. Conway argues that recycled
steel quality is not a big issue and that the real issue the
manufacturers are struggling with is whether they'll be able
to churn out enough of the relatively cheap rolled steel
which they currently make, which is used in packaging products
like cans. In terms of Britain giving up
its self-sufficiency, Conway points out that virgin steel
making in the UK is already hugely dependent on imports, as
Britain stopped mining iron ore decades ago and already relies
on imports from Sweden, Brazil and Australia.
Additionally, most of the coal used in British steel mills is
imported from Europe and further afield.
He points out that even in the run up to the Second World War,
the UK was heavily reliant on iron ore imports from Sweden, as
was Germany, to manufacture ships and other weapons.
The idea that holding on to blast furnaces for the purposes
of self-sufficiency doesn't seem to hold much water.
According to the Financial Times, the UK produces 10 to
11,000,000 tons of scrap steel each year, the majority of which
is exported, with more than half of it being shipped to Turkey,
Egypt and India for processing. This is considerably more in
exports than the 6,000,000 tons of virgin steel produced in the
UK every year. Based on these figures, it can
be argued that moving from virgin steel production to steel
recycling in fact decreases the UK's reliance on imports.
In terms of the military need for steel, I've no real
expertise on that front and was unable to find figures for the
UK, but in the United States around 3% of steel demand comes
from defence and military end users, with the main uses of
steel being construction and automotive manufacturing.
From a strategic perspective, Western economy should possibly
worry more about critical minerals, which are used in
manufacturing semiconductors and in military and communications
equipment, as China produces 98% of the world's gallium and 60%
of the world's germanium, according to the US Geological
Survey. China began imposing export
restrictions on these critical minerals last year in response
to US controls on sales of chips and chip making equipment,
saying that the export restrictions were needed to
safeguard China's national security and interests.
It's steel is easily procured, but the entire planet relies on
China for critical minerals. It might be more worthwhile to
focus on that supply chain with regard to protecting steel
worker jobs. The transition to more modern
electric arc furnaces is likely to involve layoffs, as these new
furnaces require far fewer workers than the existing blast
furnaces do. So about 5600 jobs are expected
to be lost in the UK just because of the upgrades and I'm
not sure how many steel workers will keep their jobs over the
three or more year period when the plants are being upgraded
for for this reason, British steel workers have been
threatening to strike, saying that they're not just fighting
for their jobs, but fighting for the future of their communities
and the future of steel. The threatened strikes were
suspended when Tata warned that it would bring forward the
planned furnace closures if walk outs went ahead.
So should governments be subsidizing businesses at all,
and in particular, should they subsidized foreign owned firms?
When governments subsidized specific companies with billions
of dollars of taxpayers money and put restrictions in place on
foreign competition, the policies can definitely be
expected to have an effect in the real economy.
But what does the taxpayer get in return?
If the trade interventions generate huge private investment
where factories are built and workers are employed, boosting
the national economy and generating a return on
investment, then the government's gamble will have
paid off. If, on the other hand, you end
up with weak companies and weak industries that can only get by
under continued protection or support, the taxpayer loses out
and either the owners of the subsidized businesses or the
workers in the chosen industries win out at the expense of
society as a whole. AstraZeneca, the British Swedish
pharmaceutical company, recently warned that it might move its
vaccine manufacturing side abroad because of recent
government negotiations to reduce state aid promised for
the project. According to the Guardian, at
least 97% of the funding for the development of the vaccine came
from taxpayers or Charitable Trusts.
According to the FT, AstraZeneca told UK government officials
that they're considering moving the facility to the United
States, where generous government financial support is
offered. Reuters reports that company
bosses in the UK have warned that Britain is falling behind
the United States, which has benefited from the huge
subsidies of Biden's Inflation Reduction Act, and the European
Union, which also has incentive schemes in place.
What's today known as British Steel already went bankrupt in
20/19. It had been bought from Tata
Steel in 2016 as a loss making business by a private equity
firm who paid £1.00 for the business, promising to invest
more. Over the next two years it
flipped to profitability, paying £3,000,000 per year to its
parent company along with 17,000,000 lbs in interest on a
loan. The government gave British
Steel a $152 million loan in 2019 so that it could pay CO2
emissions fees to the EU as it had been excluded from the E US
Carbon Emissions Trading Scheme due to a no deal Brexit.
The company collapsed into bankruptcy just three weeks
later when the British government refused to advance it
an additional $38 million to cover short term financing
needs. We'll be back after a quick
break. It's like our brains have a mind
of their own when it comes to money, right?
Yeah. It's crazy.
We're diving into that today, how our brains really deal with
money. We're going deep on this one,
looking at money and how we decide behavioral research.
This stuff is like eye opening. Seriously, it turns out our
brains aren't always rational, especially with money.
No kidding. So what's the deal with that?
Why are we so bad at making, you know, sensible financial
decisions? Well, our brains are kind of
lazy in a way. They love taking shortcuts.
It was then bought out of bankruptcy by Jingyi Group, it's
current Chinese owners, for £70 million, which is around $92
million. Jingyi agreed to invest $1.6
billion into the business at the time, but only invested $200
million, according to The Telegraph.
They are now asking for an $800 million subsidy, which is a bit
over 2 1/2 times the money that they themselves put into the
business. Earlier this year, Jiny's
auditors, Moore Kingston Smith, unexpectedly resigned just days
after the company released its financial filings for 2021, more
than a year after they were due. This auditor had only been
appointed one year earlier after its predecessor Mazars quit.
More Kingston Smith cited problems with the audit of
inventory such as raw materials and equipment, stating that they
had been unable to satisfy themselves over the existence of
£45.8 million worth of inventory despite trying to verify through
alternative means. They issued a qualified audit
opinion. You really have to question if a
government should provide a huge subsidy far in excess of the
value of the business or what its owners paid for it, to a
company that seems unable to prove the existence of inventory
that they are carrying on their books.
According to Wikipedia, there are 3200 British employees at
British Steel. With an $800 million subsidy.
It would cost the British taxpayer $250,000 per person to
save each job, assuming that Jing Yi doesn't come back
looking for further subsidies. According to UK Steel, the UK's
electricity wholesale price is more than double the cost of
French and Spanish electricity. The British steel industry is
already heavily reliant on electricity and this demand will
only grow as new electric arc furnaces come online.
UK Steel says that with the change, it's expected that the
sector's electricity consumption will roughly double.
Last year, the British government announced measures to
support employers in sectors including steel, metals, paper
and chemicals that are among those most exposed to the high
cost of electricity. Based on these facts, we do have
to question if the UK is even a good place to manufacture steel
at all. If some onshore manufacturing is
needed for military purposes, should the cost of an
appropriately sized steel mill come out of the military budget
rather than the government subsidizing foreign firms to
manufacture steel uneconomically in the UK?
In the British government's own report, they describe how more
steel is being produced globally than there's demand for, and
that a glut of steel has pushed prices down.
It's difficult to justify spending so much taxpayer money
subsidizing an industry that has such a poor outlook.
If there's more supply than demand and you're competing with
subsidized steel from China, at what point can you reasonably
expect to ever see a return on this investment?
To highlight how bad the situation in the steel industry
is, Brazil recently announced quotas and tariffs on cheap
imported Chinese steel. Now, while China does mine some
iron ore, it buys the majority of its iron ore from Australia
and Brazil. The fact that Brazilian steel
mills, where wages are probably not too high, are struggling to
compete on price with competitors who buy their iron
ore in Brazil, ship it 11,000 miles to China, convert it into
steel, and ship the finished good 11,000 miles back to Brazil
tells you that this is not a great business to be in.
It would be easy for me to oversimplify and claim that
there's an obvious solution to these trade problems that we see
today. But very smart people are
working on these problems, and they're likely considering
everything I've brought up in this video and much more.
Milton Friedman argued that exports are the cost of trade
and imports the return from trade.
The only reason to export is to have the money to pay for
imports. He argued that there's no reason
for a country to want to export more than they're importing.
And I think he's right about that.
Unfortunately, this sort of balanced free trade that's based
on the law of comparative advantage is not something that
we've seen in recent decades. As many emerging markets pursue
a strategy of keeping wages low and subsidizing industries so
that they can export far more than they import, sacrificing
profitability for growth, this strategy doesn't make much
sense. It eventually leads to all of
the problems that Japan is dealing with today.
Hugh Hendry has joked that countries pursuing this strategy
are great at generating GDP but not profits, and there's not
much point in that. Michael Pettis recently wrote in
the FT that the global trading system has long diverged from
one in which countries specialize and benefit from the
comparative advantage based trade that economists talk
about. The theory of comparative
advantage says that the global economy benefits when different
countries specialize in the products they can produce
comparatively more efficiently, exchanging them for products
that other countries can produce comparatively more efficiently.
Pettis points out that it's a lot trickier to trade with
countries who are willing to dump goods abroad below their
cost of manufacture, as while you're getting cheap goods,
which is a win, if they persist long enough, your industry can
be wiped out. This isn't a smart strategy from
the exporting countries perspective either, as
eventually they may end up with the biggest factories in the
world, but if their trade policy cause unemployment abroad, they
find themselves having sold goods on credit to customers who
can't pay them and who are no longer buying more goods.
Everyone loses in such a situation.
Almost all economists support free trade based on comparative
advantage, as this maximizes the value of goods and services
produced by the global economy. But Pettis argues that the
excess savings and persistent trade surpluses that we see
today are not signs of comparative advantage based
trade or signs of a healthy system of international trade.
He argues that the current global trade regime subjects
deficit economies like the US to an industrial policy, but not
one of their choosing. Instead they end up with the
obverse of the industrial and trade policies of their most
aggressive trade partners. Over the last few decades,
globalization has brought down the price of goods.
For example, 50 years ago you couldn't buy AT shirt for the
inflation adjusted dollar that you can do today and have it
shipped to your house for free. I don't agree with subsidizing
manufacturing, especially in industries like steel where the
UK has no competitive advantage today and it's not clear that
one will appear in the near future, especially when the cost
of electricity and raw materials is so much higher in the UK than
it is abroad. The recent slowdown in China has
meant even lower Chinese consumption, and because the
same amount of goods are being produced, the surplus is just
being exported. The recent increase in exports
from a country that was already a huge exporter has LED
politicians around the world to implement protectionist measures
to defend local industry. We're seeing this with electric
vehicles where the United United States, Canada and the EU have
all increased tariffs on Chinese EVs.
Britain has not done this yet, likely because in the post
Brexit environment they don't want China imposing tariffs on
British goods. Britain already has enough trade
problems to deal with. The long downturn in the British
steel industry is part of a broader decline in industry and
manufacturing that many argue played a big role in reshaping
politics, leading to the UK's vote to leave the EU in 2016.
A British government research report describes steel as being
an intensively traded product where a glut of steel on global
markets has depressed its value. It says that governments
participating in the OECD Steel Committee consider excess
capacity as being one of the main challenges facing the
global steel sector today. It goes on to say that steel
industries are often heavily subsidized by national
governments, resulting in production levels are exceeding
what the market needs would otherwise dictate.
In such a situation and in such a competitive environment, would
it be better for the British government to allow the steel
mills to just fall into bankruptcy with their foreign
owners taking the loss? If it makes economic sense to
build new electric arc furnaces, a new company could step in to
do this. I'm not sure that the existing
management are needed. It doesn't sound like a great
business opportunity to me at present.
So there's a good chance that left alone, the steel mills
would just shut down. But at least it wouldn't involve
taxpayers providing a subsidy to foreign firms greater than the
foreign firms own investment in their own businesses.
I will of course be interested to hear my viewers thoughts in
the comments section. International trade is a very
complex topic and a topic that affects the lives and
livelihoods of many people and we do have to keep that in mind.
Thanks for tuning into this week's podcast.
A special thanks to my supporters on Patreon whose
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